PEER COMPANIES

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PEER COMPANIES

Dipen Sheth, Head of Research at HDFC Securities says though it is good to bet on Hero Moto, ITC and Infosys, big money has also been made in midcap IT companies like L&T Infotech and Mphasis.

Edited excerpts:

Why do you say FY19 will be more volatile than FY18?

We have already had early indications of that in the last quarter of the trailing year. We got all excited in January after the budget and then we had that big crack coming all the way up to the end of March. Even from the lows of March, we have pulled back some 700-800 points.

It had appeared earlier as if we were getting some kind of a free ride out of DeMonetisation in December 16. All of CY2017 was like a one-way up move and everything began to gradually fall into place. We got a little complacent especially in the time after the budget.

Global uncertainty had also been picking up as well. So, the “lucky din” as I kept calling them receded a bit with oil pulling back and the structural risks in the Indian economy becoming evident all over again.

Now, we have pulled back from those lows of March. There is prospect of monetary tightening in both in the Eurozone and in the US as the Fed has signalled two may be three rate hikes this year. The ECB is going to wind down its bond purchases even as it grapples with a less than euro friendly government prospect in Italy. This is going to be a very interesting year and there are lots of pushes and pulls happening from different directions in India. Not everything is bad and though we gradually migrated into the GST regime, we have come back from the shock of demonetisation and we are moving steadily towards formalisation.

This is an election year and so spends in rural India will increase. The monsoon so far looks good. Consumption confidence has risen like never before. On the other hand, we are faced with this impossible trinity of the dismal signs of economics that we cannot control -- currency, monetary policy and capital flows. Though a very interesting year, 2018 is not going to be a trending market for sure.

How critical is the Trump-Kim Summit? The whole process of denuclearisation will make the markets happy. But this could turn out to be a more complicated process.

Yes, it is always more complicated than what the headlines would suggest. Feankly, sitting here in Mumbai we cannot try to figure out what Trump and Kim are going to be up to although we must admit that it has a huge bearing on global capital flows. We are barely able to figure out the dynamics of our local politics here. I do not think we should hazard guesses about where things might go. Of course, a positive outcome will be understood by us but to be able to predict a positive outcome or to kind of thump the table on a negative outcome are both ill-conceived endeavours.

I am not asking you to second guess what is going to come out of the Summit. If North Korea does plan to denuclearise, is that going to make the markets happy?

Most certainly, it will be a fairly large incremental positive. There are other parts of the geopolitical equation also. There is Turkey which is now ruffling a few feathers with its recent pronouncements and West Asia is always in some kind of a potboiler.

The fact that oil prices have gone to $70 plus not only indicates that Saudi Aramco is going to have a good issuance, but it also means that there are structural problems with large oil importers like India who are right 80-82% dependent on external supplies of crude. While the Trump-Kim outcome will soothe some frayed nerves, I do not think it will completely send markets into a runaway mode.

There is the tightening both by the US Fed and the ECB in different ways. Interest rate hikes in the US, stoppage or termination of bond purchases by the ECB over next few months will certainly keep interest rates high and monetary positions tight.

This makes capital flows into emerging markets that much more difficult. Having said that I think India is probably the most exciting emerging market in the current global context in terms of the sustainability of growth. There is still a lot of work to be done but the direction is clear. Foreign investors will use volatility this year and markets to begin investing or to aggressively invest in India all over again. You can certainly see short-term outflows which can keep markets volatile that is the net view.

You have highlighted three themes. One, is corporate capex recovery which means there is value in investment led cycle and associated businesses. You have spoken about IBC resolution which gives an opportunity window for banks to get rid of NPAs. The third theme is the cooling off in crude prices. Where do you spot the opportunity to generate alpha in this volatility?

I do not know what the next trigger for the investor is going to be. Some policy action to stir corporate capex can certainly excite some of us who have been waiting for the corporate capex cycle to take off. IBC’s NPA resolution and a crack in crude prices are structural positives but then you have some things on the negative side as well.

A sudden outflow of FPI money can certainly drive markets down and impinge on currency stability. The recent bond raising plans from NRIs by the government I suppose is part of managing that sort of volatility. Rise in the global interest rate cycle.

There are a whole lot of things and it keeps on coming back to the same old thesis that I have that things are going to remain volatile. India is in a much better position than it was may be five years ago and any long-term investor is going to use this short-term volatility to aggressively start taking positions into India. As for Indian retail investors, for those people who have made money, certainly some bit of profit taking is warranted but there are stable stocks in the market which you can use to withstand volatility.

You can even do a stock based SIP if you want to. If you are subscribed to a mutual fund, you can continue with your SIPs through the volatile period and that is how long-term wealth creation happens for retail investors.

How would volatility affect underlying earnings coming back to support markets? Would FY19 be the year when we would see earnings trending and if so, what is the kind of ballpark range you expect?

I doubt if we will see high double digit earnings in FY19. If we hit double digits, that should be good enough because parts of the Nifty now are under some kind of stress. The banking system, especially the large corporate banks whether it is an SBI, BOB or an Axis or an ICICI are certainly struggling on this .

Even with the support of earnings, the OMCs in case their earnings are left intact but the sheer expansion in their balance sheets would call for some derating and that is already visible in the way they have been behaving. Some of the large caps and some of the more stable stocks offer a very decent hedge against the kind of volatility that we are looking at right now. Names like Hero Moto comes to mind. which is coming off a sluggish phase of low volume growth. It had mid-teen volume growth in FY18 and is poised for 9-10% volume growth again over the next two years.

A dominant player like ITC is available at an all-time high discount to the rest of the FMCG sector. We do agree that it should trade at a discount but not this kind of broad discount. At 23-24X you have ITC, at 16X you have Hero Moto and if you feel that the India’s currency is going to take a hit in the phase of global capital flows turning volatile, then Infosys offers a very good hedge at about almost 25% discount as a dollar proxy, to TCS.

Infosys is rapidly getting into a phase where it is reviving its core franchise. There is a commitment for high payouts and obviously the dollar proxy makes it a very decent hedge against volatility in markets driven by capital outflows. There are your three boring largecaps if I may say so, allegedly boring large caps which offer a very decent position building opportunity over the next one year as it were as we enter markets which threaten to be volatile.

It is the boring large caps which have been giving you all the returns so far this year. Given the way the currency has been moving, do you think that the tailwind is going to remain for IT as a sector and perhaps one could invest in some of the mid-cap IT names too?

The big money, much more than the front caps, has actually been made in the mid-cap space. By midcap, I mean a whole lot of companies which are almost at or around kissing the $1 billion mark. L&T Infotech and Mphasis come to mind . There are a whole lot of stocks outside the top four or top five in the frontline IT stocks.

I have already mentioned Infosys but then HCL Tech is even cheaper. This big play on the dollar is one part of the IT story. For the last year or so, we have been thumping the table on IT saying that it is too good a business to fade into oblivion.

It has a longevity which is much more than what investors might think, especially in the face of the challenges that the movement to Cloud and automation and AI and all of that was threatening Indian companies and we have never believed that thesis.

A lot of these companies have made significant investments in the digital space, in automation and being able to free up productivity and utilisations have jumped up close to 1200 bps over the last year, year and a half.

Many of these companies have swung back into relevance in the markets where they operate in and have been able to maintain margins. It is the weakening rupee which will help them continue with a good trend. I do not think this is a trend that is going to reverse over the next one or two years so easily.

What would be your approach towards financials? Split it down between PSU banks, private banks as well as NBFCs?

NBFCs have had a dream run as we know and we are still gung-ho on many of them. Names like Chola come to mind. Some of the smaller banks come to mind. So, we have been gung-ho on DCB and City Union Bank for a while. The larger truth in the financial space is the at the government has repeatedly demonstrated its lack of capability in running large financial companies.

There are notable exceptions here. Despite all the headline pain. we still feel that a Bank of Baroda or an SBI these are excellently managed organisations and they have gone through cyclical downturns with a few hits and a few misses as it were but the rest of the PSU bank space does not really offer much comfort. You might point out an exception like an Indian Bank or something but frankly, I think, the gradual let down and the gradual giving up of market share as it were in the credit space, in the lending opportunity in India by the PSU banks and today they are close to 60-63 or 63% of the system. I do not remember the exact number but remember they started at about 100% and if this is going to be at 40% in 10 years from now.

I do not think we should feel very sorry about that. There are good PSU banks which deserve long-term investors but there is very little else to choose from frankly. And if you want to be an investor in financials, then you need to look at some of the smaller banks.

Apart from a DCB or a City Union Bank, we have recently covered RBL, headline valuations at about 2.7x on FY20 basis. It looks costly but with a Rs 40,000-crore loan book and the ability to grow at 30-35% for the next may be five or 10 years, with a very sharp and capable management. I was reading Mr Ahuja’s interview in the Economic Times recently and I completely agree with him that growth is not going to be a challenge here. A long-term investor should not look at short-term volatility in the stock and should just buy and lock up this stock for may be the next decade or so.